Government in danger of major policy mistake as house prices soar argues Ashcourt Rowan’s Stephen Walker

28th August 2013

Many commentators are expressing increasing alarm that policies to help get the mortgage market moving are dwarfing measures to increase the supply of housing and thus may create a new housing bubble. One of those is Stephen Walker, Head of Equities Research and Market Strategy at Ashcourt Rowan, a financial planning and investment management firm. The article suggests that the Government may be playing with fire in a market with a tendency towards “bubble-like behaviour”. We print the note in full below.

“On average, the health of the UK housing market is right up there with the weather as something that preoccupies a large proportion of the population; we use the term ‘health’ advisedly since it is generally associated with rising house prices. Whilst this is clearly good news for home owners (unless they want to buy a bigger house whose price has gone up more) it is even more clearly bad news for those who don’t own property but aspire to.

The UK Government, and this one appears no different to any other historically in this respect, appears to regard rising house prices as unequivocally a good thing. There is no question that the majority feel happier and wealthier if the value of their house is rising but is it really such a win-win situation? For starters, it increases the disparity between those who own property and those who do not, at the current time it advantages the 40+ generation over those who are younger and to the extent those who own property spend more of their income servicing mortgages, consumption of discretionary goods/services is reduced. This latter factor has been offset in large part because of a steady decrease in interest servicing costs, but at some point they will rise again and absent a significant boost to incomes this will surely put consumer spending under material pressure; Capital Economics estimate that a return to 6% mortgage rates would take up an additional 15% of net income.

Whilst much of the post-global financial crisis critique has been levelled at US banks and their irresponsible lending practices, many issues applied similarly to the UK. We should not forget that the failure of Northern Rock and the near failure of Lloyds Banking (because of their purchase of HBOS) were inextricably linked with the bubble in the UK housing market and the way that was funded. It appears that people have short memories and there is already a certain ‘frenzy’ amongst people to buy before prices rise further.

With their attempts to boost housing construction, the UK Government appears even more complicit in this than usual. They are correct to identify the shortcomings in terms of new supply but our issue is that the measures to boost supply are dwarfed by the magnitude of the measures to boost demand. Up until recently, many first-time buyers wanted to buy but lacked the access to mortgage financing to do so, something addressed by the recent Help to Buy scheme. Located as I am in the South East it is easy to think of the housing market as being well advanced into another price boom with wealthy foreign buyers putting upward pressure on London house prices, but when the whole country is taken into account this is not the case.

It is often said that UK house prices are higher than elsewhere because of the shortage of land; in fact, population density is not that high outside the South East of England. A more likely explanation is that a limited number of large house builders deliberately restrict the rate at which they build new houses in order to put upward pressure on house prices and thus increase the value of their very substantial land banks. As potential investors we clearly have sympathy with an approach involving a focus on profits more than volume to the likely benefit of shareholders but it is equally obvious to us that this leads to higher house prices than would otherwise be the case. There appears to be a certain impatience with land banking by house builders within Government and there is a chance that an inadequate supply response may lead to use it or lose it type measures in future.

With expectations that net immigration will further drive housing demand in the future, the UK Government has quite rightly identified the need to trigger a positive supply response from UK house builders. A raft of measures have been put in place, most recently schemes such as “Get Britain Building” and “Growing Places” and the signs are encouraging on the face of it with house builders accelerating development plans. The major problem for us is that new house building is a long way below a normal level and the demand response because of schemes like “Help to Buy” is not only larger but almost instantaneous whereas clearly it takes time to develop plots of land, build houses etc. Once the scheme allows the purchase of existing housing stock in 2014 there must be a danger that the house builders miss the boat and the main outcome is much higher house prices. We think there is a danger of a major policy mistake here that may result in large problems in a few years’ time though we acknowledge this is being done with the best of intentions. In a market with a tendency towards bubble-like behaviour it could be seen as playing with fire.

In our view, there are two underlying issues that need addressing. One of these is to address the new supply issue which continues to lag by a long way the growth in population and remains a long way below historic building levels; incentives to house builders that deter ‘land banking’ would appear to be the best way to achieve this. The second is to address the availability of mortgages where high deposits prevent many first time buyers from getting on the property ladder. It is important to remember that banks advance mortgages using the underlying property as security so if they believe that house prices are too high it is only natural that they should want a meaningful buffer of equity.

The current strategy appears to be to hand out deposits like confetti but this is very dangerous as it takes virtually no change in house price to wipe out a buyer’s equity in their house. Whilst buying with a 5% deposit sounds like a great idea it means that people are in fact using gearing of 19x to buy a house they may not be able to really afford. There always seem to be concerns about a China housing bubble because prices rise perennially but putting down 40-50% cash deposits remains a normal state of affairs. In the UK it looks like either first time buyers need to make more sacrifices to save or lower their sights; if new demand develops way below current house prices that should eventually have an impact just as it does with any good or service.

Demand and supply for any good or service is not fixed; it is a function of price and there is no reason why the UK housing market should be different. If left to its own devices the market would surely find an equilibrium at a lower level and it is yet another example of policy makers interfering with market forces and then no doubt capitalism will get the blame if/when it goes wrong; the whole policy smacks of political expedience over economic sense.”

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